Committed Capital

Committed capital is the total amount of money that investors agree to contribute to a private equity fund over a specified time period. Rather than immediately investing the entire capital at once, committed capital represents a promise from limited partners (LPs) to provide funds as they are needed. The fund manager (general partner or GP) draws this capital down from LPs to execute deals via a process known as capital calls.

This concept also includes terms like committed funds, capital commitment and private equity commitment. These are synonymous terms that reflect the amount of money an investor has pledged to a PE fund but not yet provided in full.

Key takeaways

• Committed capital is the total amount of money an investor pledges to a private equity fund.
• Capital calls allow funds to draw on committed capital when investments are identified.
• Investors do not provide all of the committed capital at once; funds are called over time as needed.
• Committed capital gives flexibility to both investors and fund managers in managing cash flows.

How committed capital works in private equity

Investor commitment phase

In private equity, committed capital is central to the investment lifecycle. During the investor commitment phase, investors pledge capital to a fund, but the money is not required to be transferred immediately. The private equity firm may spend months or even years raising committed capital from a wide pool of investors to reach its target size. For example, a fund may aim to raise $500 million in committed capital to pursue investment opportunities over the course of its lifecycle.

Once capital is committed and the fund holds a first close, it enters its investment period, during which it seeks out and invests in portfolio companies that align with its strategy.

Capital calls

A capital call occurs when the private equity fund identifies an investment and requests that investors transfer a portion of their committed capital to complete the transaction. Capital is typically called in stages and investors are given a notice period—usually between 10 to 14 days—to provide the requested funds.

Capital calls happen throughout the fund’s life, generally over a period of several years. A private equity firm may call on a portion of its $500 million commitment when it needs to acquire businesses or fund the expansion of existing portfolio companies.

Fund lifecycle and deployment of capital

The committed capital is deployed as investment opportunities arise. For example, if a private equity firm raises $500 million in committed capital, it may initially draw $50 million to acquire its first portfolio company. Later, as new opportunities present themselves, it will continue to make capital calls until the full $500 million is invested.

The deployment of capital occurs over several stages:

1. Initial investment period – where the bulk of the capital is deployed.
2. Growth and management phase – where the private equity firm manages the portfolio and seeks to improve operations, increase efficiency and grow revenues.
3. Exit phase – where the firm divests its investments, returning the proceeds to investors, typically generating a return on their original capital commitments.

Benefits of committed capital in private equity

Advantages for investors

• Flexibility in timing: Investors don’t need to provide the entire investment amount upfront, allowing them to plan for cash flows and liquidity needs.
• Lower immediate outlay: Since capital is called in stages, investors only need to provide funds when needed, reducing the immediate financial burden.
• No cash burn: Committed capital remains with the investor until called, preventing cash from sitting idly and ensuring it is only used when there are concrete investment opportunities. This means investors can earn a return on this capital elsewhere before it is called.

Advantages for private equity funds

• Liquidity management: Committed capital gives fund managers access to funds as they need them without sitting on large amounts of unproductive cash, which would dampen returns.
• Funding predictability: Since commitments are legally binding, GPs benefit from certainty of funding as and when they identify deal opportunities.

Committed funds vs. obligated funds

Committed funds

Committed funds refer to the total capital that investors have pledged but have not yet transferred to the private equity fund. It is an agreement between the investor and the fund, signifying a promise to provide the necessary funds upon request.

Obligated funds

Obligated funds represent committed capital that becomes due once a capital call is made by the GP to its LPs. It must be used for a specific investment once the call has been issued. At this stage, the committed capital transitions to obligated capital and the investor is required to fulfil their commitment within the agreed time frame.

Capital commitment in private equity vs. other forms of investment

Capital commitment in private equity differs significantly from other investment models such as hedge funds, mutual funds and direct investments:

• Hedge funds: Typically, hedge funds involve liquid investments such as stocks, allowing investors to redeem their money more easily. Unlike private equity, hedge funds do not require long-term commitments of capital.
• Mutual funds: In a mutual fund, investors purchase shares directly in the fund, which holds a diversified portfolio of stocks or bonds. There is no need for capital calls, as all investments are made upfront.
• Direct investments: When investing directly in a company or asset, investors usually need to provide the full amount of capital immediately. This contrasts with private equity fund investing, where capital commitments are drawn over time.

Risks and challenges associated with committed capital

Risks for investors

• Capital availability: Investors must ensure they have available cash when capital calls occur, which may create liquidity challenges if not carefully managed.
• Time lag: The delay between committing capital and actually investing comes at a cost to LPs. This is because PE funds charge an annual management fee on committed capital before it’s deployed.

Risks for private equity firms

• Investor default risk: One of the biggest risks for GPs is that investors may fail to fulfil their capital commitments during capital calls. This is known as "funding risk." If LPs default on their commitments, it can disrupt the fund’s ability to execute planned investments and may prompt the GP to initiate legal remedies to enforce the commitments.
• Time lag: Time lag risks also apply to GPs. If suitable investment opportunities aren’t identified within a reasonable timeframe, committed capital may remain idle for longer periods than anticipated. This can reduce the effectiveness of the fund by impacting investor returns and the GP’s performance track record.

Committed capital is a cornerstone of private equity investing, ensuring a steady flow of funds for deals as and when required. For GPs, it represents a legally binding pledge to provide the necessary funds for transactions. For LPs, the commitment structure enhances financial flexibility by allowing capital to remain productive until it is actually called, maximising potential returns outside of the fund.

Important notice: This content is for informational purposes only. Moonfare does not provide investment advice. You should not construe any information or other material provided as legal, tax, investment, financial, or other advice. If you are unsure about anything, you should seek financial advice from an authorised advisor. Past performance is not a reliable guide to future returns. Don’t invest unless you’re prepared to lose all the money you invest. Private equity is a high-risk investment and you are unlikely to be protected if something goes wrong. Subject to eligibility. Please see https://www.moonfare.com/disclaimers.